Wednesday, 4 March 2015

Oil Price. Good For The Economy, Terrible For Financial Markets - Part 12

Circulating Constant Capital 

The world consumes around 30 billion barrels of oil per year. At its previous price of around $110 per barrel, that is an approximate value of around $3.3 trillion, whilst total global GDP is estimated at somewhere between $75 – 87 trillion. Using the lower value, that means that oil accounted for around 4.4% of global output value. The fall in its price to around $45 per barrel reduces its total output value to around $1.35 trillion, or about 1.8% of global output value. Although, the fall in the oil price, badly affects the rate of profit in the oil industry itself, and will have a knock on effect on the rate of profit in those industries that are closely associated with it, in terms of the development and maintenance of oil fields, pipelines and so on, its quite clear that at such a small percentage of total global output, and capital value, this cannot significantly affect the global rate of profit adversely. More significantly, for the reasons Marx sets out in Capital III, Chapter 6, the fall in the price of oil, as an important raw material, acts to raise the rate of profit in general.

“Since the rate of profit is s/C, or s/(c + v), it is evident that everything causing a variation in the magnitude of c, and thereby of C, must also bring about a variation in the rate of profit, even if s and v, and their mutual relation, remain unaltered. Now, raw materials are one of the principal components of constant capital. Even in industries which consume no actual raw materials, these enter the picture as auxiliary materials or components of machinery, etc., and their price fluctuations thus accordingly influence the rate of profit. Should the price of raw material fall by an amount = d, then s/C, or s/(c + v) becomes s/(C - d), or s/((c - d) + v). Thus, the rate of profit rises. Conversely, if the price of raw material rises, then s/C, or s/(c + v), becomes s/(C + d), or s/((c + d) + v), and the rate of profit falls. Other conditions being equal, the rate of profit, therefore, falls and rises inversely to the price of raw material. This shows, among other things, how important the low price of raw material is for industrial countries, even if fluctuations in the price of raw materials are not accompanied by variations in the sales sphere of the product, and thus quite aside from the relation of demand to supply.”

Oil is almost unique in that it enters as a raw or auxiliary material in every type of product, as well as in transport. The fact that oil comprises currently only around 1.8% of total global output value, might suggest that any change in its price could only have a marginal effect on profitability. However, the 1.8% figure is the share of output value, not the share of production costs. If global profits are estimated at around $10 trillion, that gives total production costs of around $65 trillion.

On that basis, the original cost of oil comprised around 5% of total production costs, and this will have fallen to around 2%. Put another way, the fall in the price of oil has released around $2 trillion of capital into the global economy. That is additional capital that can be accumulated in addition to the $10 trillion of global profits, only part of which would have been accumulated. If half of the $10 trillion of profits are accumulated, and the other half consumed as revenue, this release of an additional $2 trillion of capital is the equivalent of making possible a 40% increase in potential accumulation. In short, if global growth was previously estimated at around 4%, it would increase this to around 5.6%.

But, in fact, the proportion may be greater than that, because, as Marx points out, one consequence of a fall in commodity values, is that capitalists and other exploiters themselves have to lay out less money as revenue, to buy the commodities required for their own unproductive consumption. The less they have to expend for these purposes, the larger the share of total profits available for accumulation.

The effects on the rate of profit, and potential accumulation of capital, obviously vary depending upon the extent to which oil forms a more or less significant component of the production costs in any industry. In the petrochemical industry, for example, oil forms the basic raw material, and consequently the fall in its price, both raises the rate of profit, as less capital needs to be advanced to buy any given quantity of raw material, and also leads to a release of capital, equal to this reduced value, which can then be used for purposes of additional accumulation.

Another example would be a transport company. Take a taxi company, it may advance £20,000 as fixed capital to buy a taxi, which it expects to last for 10 years, losing £2,000 p.a. as wear and tear. The taxi covers 600 miles per day, or 216,000 miles per year, consuming 10,000 gallons of petrol, at a cost of £100,000. Overhead costs amount to a further £10,000 p.a. It pays, £30,000 in wages, and makes £74,000 in profits, with total revenues of £216,000, or £1 per mile. The rate of profit is then p/k = 52%.

If the price of petrol falls in half, and this is passed on in a lower charge per mile, this becomes costs of £2,000 (wear and tear) + £50,000 (fuel) + £10,000 (overheads) + £30,000 (wages). Total revenues fall to £166,000, leaving £74,000 in profits. The rate of profit thereby rises to 80.4%. An increase of 60%. But, the fall in the price of oil (this is not accurate because the fall in the price of oil does not translate directly into an equivalent fall in petrol prices, but is made for illustrative purposes) means that less capital must be laid out to operate on this scale.

£50,000 of capital has been released. This £50,000 of capital released as a result of the fall in the oil price could then be used to buy an additional taxi costing £20,000, leaving £30,000 of capital to employ labour. In other words, the potential to expand at an enhanced rate is established.

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